G-Sec rally puts gilt funds under spotlight

Gilt mutual fund schemes, which invest in government securities (G-Sec), are back in vogue, as institutional investors and rich individuals are betting the ongoing rally in these bonds would fetch them double-digit returns. Mutual fund sector officials say gilt schemes are attracting higher flows this month. In April, this segment saw renewed interest, after a two-month fall in popularity.

Fund managers said due to the fall in inflation, there were expectations of a sharp policy rate cut at the central bank's meeting in June, and this had resulted in a fall in government bond yields (or the rally in prices). Yields and prices are inversely proportional - when yields fall, prices rise. Gilt funds benefit when bond prices rise, as they do not hold the securities to maturity and churn returns through trading.

Today, the yield on the 10-year government bond fell to 7.39 per cent, against eight per cent on April 1 and 8.2 per cent late last year. "In April, when the yield on the 10-year bond was about eight per cent, many investors got into gilt schemes," said Navneet Munot, chief investment officer (CIO) at SBI Asset Management.

In the last six months, the gilt fund category has recorded average returns of 9.17 per cent. These schemes, which have returned 14.6 per cent in a year, have been the best performers in the fixed-income category. Income funds have returned 13.13 per cent in a year.

"I believe from here, inflation would continue to show a downward trend and rates could fall by 75 basis points, which would positively impact returns from gilt schemes. Investors can make double-digit returns in gilts from a one-year perspective," said Murthy Nagarajan, head of fixed income at Tata Mutual Fund.

In a recent debt market survey of foreign institutions by Barclays, most respondents said they planned to increase exposure to government bonds through the next three months. However, very few expected the 10-year benchmark to exceed 7.25 per cent; most felt the yield would be about 7.5 per cent.

"From here, the movement in bond yields depends on what RBI (Reserve Bank of India) does," said Alok Singh, CIO (fixed income) at Bharti AXA Mutual Fund. "Markets seem to be discounting one rate cut (June) and from a year's perspective, eight to nine per cent returns are quite achievable."

The government's borrowing programme also has a bearing on government bond prices, as the extent of paper supply partly determines the direction of yields - when the supply is high, bond yields rise, depressing prices. But this year, fund managers are more focused on the central bank's moves, as the government's borrowing is not expected to breach the target for this year.

Currently, the total assets under management of 43 gilt schemes stand at Rs 9,181 crore, about one per cent of India's total mutual fund assets.

"Considering the size of papers the government issues, the size of gilt funds is still very small. There is huge potential in this segment," said Munot.

Distributors said gilt schemes have largely been a "trading product", as investors usually invest or withdraw according to their outlook on the 10-year government bond.